Contracts Must Be Reasonable
Contracts, which are intended to eliminate problems, can be the open doorway to disputes and claims. Contracts that are one-sided promote dispute resolution through litigation. Bias in contract language and interpretation leads to increased costs for all parties. The following article suggests ways in which owners and contractors can work toward equitable contracting.
Disruptions or Disputes Are Expensive to Both Owners and Contractors
Construction contracts are drafted to allocate responsibilities, risks, and remedies between the separate parties. This allocation is based upon the simple fact that someone must be responsible and someone must pay for all elements of the project under that contract.
In theory, when changes or unforeseen difficulties arise on a construction project, the allocation of risks established by the construction contract will clearly identify the party who is to pay. Thus, in the case of an owner’s directive to add to the scope of work, most contracts clearly provide for adjustment of the contract price to compensate the contractor for the cost of the additional work.
How, then, do disputes arise? When the contract is ambiguous, inherently unfair, or provides no remedy, changes very easily escalate into disputes. Owners or designers who draft contracts that shift risks that were traditionally theirs to the contractors, may do this in the belief that they are avoiding those risks. But contractors, who generally have little or no bargaining power when they enter such contracts, cannot accept those risks and survive. Thus, almost universally, contractors will seek recovery of costs that were not of their making, regardless of contract language. They are encouraged to do so by an American legal system that has been slanted against the drafters of unfair contracts.
Disputes also arise because of the people who administer contracts, in spite of contract language. Conflict of interest is commonplace as owners typically establish themselves, or their representatives, as the day-to-day interpreters of contracts. Bias may easily result when interpretations affect time and money. Yet such bias is as misplaced as biased contract language. If contractors are denied compensation to which they believe they are entitled to under the contract, a dispute is virtually inevitable, and unless the contractor has misread the contract, the courts may be expected to side with the contractor.
Disruptions or disputes on a construction project are expensive to both the owner and the contractor. The owner, in addition to construction cost overruns, has costs of invested capital and other resources that will not produce the anticipated return until the facilities are functioning in a useful manner. The contractor, in addition to incurring costs of equipment, personnel, financing, and bonding that are tied to a project, loses the opportunity to utilize these resources on other potentially profitable work.
In construction contracts, the interests of all are best served when the contracting parties cooperate. This collaboration is also an economically sound practice to avoid the added cost and disruption generated by disputes.
Bias in Contract Language
Writing tightfisted contracts in the belief that they will control costs is unrealistic and unproductive. Standardized construction contract forms have been drafted and promoted by the architectural and engineering professions and by contractor and subcontractor organizations. Public and private owners have developed their own forms. At least one intent of these standardized forms is minimizing the risks of the drafting party at the expense of the other parties.
In recent years, contract agreements and specifications that are heavily biased against contractors and subcontractors have emerged. Exculpatory clauses are inserted to prevent a contractor from receiving compensation for unforeseen costs in numerous situations over which the contractor has little, if any, control. Thus no-damages-for-delay clauses and provisions making the contractor fully responsible for differing and unforeseen conditions are commonplace.
The inclusion of exculpatory language rarely has the effect owners anticipate. In fact, such language is not likely to reduce project costs. It will more probably increase costs through protracted disruption to the project and added legal expenses. The American Society of Civil Engineers addresses the impacts upon project cost and administration of unforeseen site conditions because of language in contracts “Managing Unforeseen Site Conditions,” Journal of Construction Engineering and Management, June 1987 by Halligan, Hester & Thomas. This analysis was based upon information from several unpublished studies, the majority of which were sponsored by the federal government. The conclusions include the following points:
- Contractors make claims for unforeseen site conditions because overriding economic pressures prevent them from including such costs in their bids.
- The proportion of costs for unforeseen site conditions borne by the owner is largely unaffected by contract language.
- Management techniques that encourage early resolution tend to reduce the costs of changes and claims.
- Contracts that place all of the responsibility for site conditions on the contractor do not prevent claims, but they do prevent the situation from being managed, since the field and lower management are rarely in a position to disregard a contract clause.
- Contracts that permit extra payment for unexpected site conditions do not lead to an increase in the cost to the owner, but they do permit early resolution of disputes and management of the situation.
The United States suffers from a litigation explosion that has generally been blamed on tort lawsuits by individuals. However, our experience tells us that the construction industry is responsible for a significant share of this excessive litigation.
Exculpatory language in contracts does not prevent lawsuits, nor does it reduce costs.
Bias in Contract Administration
If the construction manager is also the designer of the project, a high possibility exists for a conflict of interest. The construction manager’s objectivity is placed in question when changes in the work become necessary. He or she may be reluctant to authorize additional time or compensation for work that might be viewed by the owner as a design deficiency. If professional liability is questioned, the conflict is compounded.
Recommendations to Owners
Owners frequently obtain assistance from specialists in areas such as architecture, engineering, construction management, law, insurance, real estate, and contracting. These services should provide the owner with insight and expertise that not only enhance the project, but also minimize problems.
Prior to selecting professional services, an owner should review and establish the rights, responsibilities, and conditions under which the providers of various services are expected to perform and their relationships with each other. Cooperation and mutual respect are required between all parties if disputes are to be minimized.
When selecting an architect, engineer, construction manager, or contractor, owners should require references from projects over the past few years. Owners need to contact these references and seek information from all parties about past experience with changes, change order management, disputes, and litigation. It may not be possible to sort out responsibility for each dispute. Indeed, few situations have only one culpable party. Nonetheless, owners should scrutinize any professional with a pattern of involvement in disputes.
Cooperation and Respect Are Required between All Parties
For “fixed” price projects, design work should be completed to the fullest extent possible prior to issuing the bid documents. Even then, all parties should recognize that modifications are likely to be required. Project funding must include a reasonable contingency for changes and extras, and contract language should allow changes and unforeseen events to be handled quickly and in an equitable manner.
A poorly planned or mismanaged project will invariably result in added cost and delay. An owner should not ignore the project or leave administration entirely in the hands of others. Instead, an owner should monitor the work, review correspondence, periodically meet with key firms involved in the project, and generally stay well informed about the project status.
Recommendations to Contractors
Contractors should read, analyze, and understand the contract before bidding and evaluate the risks. If a contract has onerous language that is not negotiable, and an appropriate cost cannot be included in the bid estimate to cover this exposure, contractors should seriously consider not bidding on the work. Also, contractors must maintain complete and accurate records.
Contractors should investigate the contracting history of the owner, designer, and construction manager. If a past pattern of disputes exists, the contractor should
- Try to negotiate contract terms that will protect the contractor
- Increase the bid price to cover contingencies, or
- Consider not bidding
If a construction manager is appointed as an intermediary without clear and explicit authority to act as the owner’s agent, ensure that the owner is kept informed of any changes at all times, particularly when the construction manager issues an instruction that will result in extra time or cost.
During the course of the project, the contractor should
- Perform work in a professional manner
- Meet the deadlines established in the contract for submittals and for the construction
- Keep complete and accurate records, and
- Price changes carefully and realistically, with detailed support
A Call to Reason
The principal participants in the claims process-the owners, designers, and contractors-are directly impacted by the current state of claims resolution in the construction industry. Certainly the American contracting system is in need of fundamental change. Our multiparty, adversarial system, operating in the shadow of litigation, is not as productive or innovative as it should be to compete effectively in a global marketplace. No one party can change this; however, each of us can help by moving toward fair and reasonable contracting in which each party performs professionally to construct quality products.
Source: Interface Consulting International, Inc.
Released: July 30th, 2007 11:00 AM
Phone: (713) 626-2525
Fax: (713) 626-2555